Question

1. Compute the component costs of capital for a firm with the following information:

a. A bond that has a $1,000 par value and a coupon interest rate of 11%, paid semiannually. The bonds have a current market value of $1,125 and will mature in 10 years.

b. A common stock issue that paid a $1.80 dividend last year. The firm’s dividends are expected to continue to grow at 7% per year forever. The price of the firm’s common stock is now $27.50.

      c. A preferred stock that sells for $125, pays a 9% dividend and has a $100 par value.

Answer 1

a)

Number of periods = 10 * 2 = 20

Coupon = (0.11 * 1000) / 2 = 55

Cost of debt = 9.07%

Keys to use in a financial calculator: 2nd I/Y 2, FV 1000, PV -1,125, N 20, PMT 55, CPT I/Y

b)

Cost of common stock = (D1 ./ share price) +growth rate

Cost of common stock = [(1.8 * 1.07) / 27.5] + 0.07

Cost of common stock = 0.07004 + 0.07

Cost of common stock = 0.14 or 14.00%

c)

Dividend = 0.09 * 100 = 9

Cost of preferred stock = (Annual dividend / share price) * 100

Cost of preferred stock = (9 / 125) * 100

Cost of preferred stock = 0.072 or 7.2%